The financial crisis plus the numerous reforms of German tax laws – is this reason enough for the wealth manager to turn away from the German market and to look for a quieter life far away from hostile tax regimes?
The answer is no for two reasons: firstly, crisis and change create opportunities. Secondly, the OECD has at its Cape Town meeting earlier this year committed to plans for a global tax attack on the private wealth business – so there won’t be a lot of safe places left on this planet. So rather it is best to tackle the issue and deal with it.
The current situation
The first step to take is a rigorous analysis of the current situation. As from 1 January 2009 the German taxation rules for private investments will change fundamentally. There will be a flat rate withholding tax (WHT) on dividends and interest income as well as capital gains of 25 per cent and an additional solidarity surcharge of 5.5 per cent thereof (overall: 26.375 per cent plus church tax if applicable). The tax exemption for capital gains on the sale of privately held assets will be abolished.
Furthermore, the German legislator is in the process of creating modifications regarding taxation of investment funds’ earnings, which are going to be enacted in 2009 (Annual Tax Act 2009, "Jahressteuergesetz 2009").
At the same time, the financial crisis has led to dramatic losses on equity, bond and hedge fund investments. Cash has become king for the majority of investors, at least for the immediate future. It depends on the risk appetite of each individual whether he prefers the “super secure” savings bank account or whether he can live with non-enhanced cash fund products.
There is a great demand for safety in the market, while some investors start to spot golden opportunities from purchasing grotesquely undervalued assets.
Now, if the wealth manager wants do something to boost his Christmas sales, he may want to consider the following:
• Offer products which provide enhanced grandfathering on capital gains tax. This requires a high degree of sophistication as many avenues have been shut by the legislator, whose response time to innovative tax products has decreased substantively. If only he was as quick on other matters of greater significance!
• Offer strategies which allow for a deduction of expenses against the currently high rates and benefit from lower rates on income as of next year.
• Moving investors from one product to another without triggering intolerable capital gains tax charges.
• Tread carefully with a view to products which convert income into capital gains as they currently do not have the full sympathy of the German Minister of Finance.
• Anticipate massive redemptions: where funds do not operate equalisation, the investor who stays loyal to the fund manager until the bitter end may be the one who has to pay the tax burden for everyone who left before him. This is widely unknown and can create millions of Euros of taxable phantom income.
• Tell the client where to realise taxable losses prior to year end.
• Advise clients how to save taxes on cash products. With interest rates above five per cent, this is worth doing and, yes, it is possible.
• Reduce the filing burden for the client – the new regime introduces a completely new set of filing requirements and if products are carefully chosen, filing requirements can be reduced to a minimum.
• Respect investor preference for regulated fund vehicles over products with inherent issuer risks.
Those interested in more details on the use of fund vehicles for private investors under the new rules, should read the following overview of key changes introduced by German tax reform. In particular, the taxation until 31 December 2008 and as from 1 January 2009 will be compared for various types of funds.
Investment funds
The private investor's tax charge depends on the investment fund either earning regular income from investments (e.g. dividends, interest payments) or capital gains (irregular income) derived from sales of the fund's assets (i.e. shares, securities, real estate, others) and whether the fund's income is distributed or accumulated.
Starting from 1 January 2009, all earnings from investment income will be subject to a flat WHT on the investor's level. However, from a tax perspective, investment funds can still be advantageous as outlined below:
Equity / debt security funds
Taxation of investment fund income until 31 December 2008: The investment fund's regular income is subject to tax on the investor's level regardless if accumulated or distributed. The interest accrued at the level of the investment fund is fully taxable with the investor's individual income tax rate, whereas dividend income is subject to the half income method. Furthermore WHT is levied on both, interest (30 per cent) as well as on dividend income (20 per cent).
